Myth #5: Short selling has unlimited loss potential but limited profit potential
"Not all is lost until the lesson is lost."
– Mother Teresa
Share prices may go up multiple times but can only go down 100%. Short sellers therefore open themselves up for infinite losses and limited profits. The not-so-secret dream of every fund manager is to pass their name down to posterity. "Managers" who just sit back watching their shorts going up multiple times against them deserve to have this dream come true. They have earned the right to have their name on a plaque… at the bottom of a public urinal. There is simply no excuse for bad risk management.
On a different note, meet Joe Campbell, a young dynamic entrepreneur, and investor in his spare time. On November 18, 2015, he sold short Kalobios (KBIO) at an average cost of $2 for a total market value of $33,000. Enter Pharma Bro, Martin Shkreli, who disclosed 50% ownership of Kalobios after the close. The share price roofed at 800% in the after-hours market. Borrow vanished overnight. Unable to meet his margin call, the unfortunate short seller appealed to the sympathy of fellow traders by launching a crowdfunding campaign on GoFundMe, only to face the humiliating double whammy of market participants "revenge trading" vitriolic comments. My sympathy goes to Mr Campbell and may at least his story serve as a lesson to aspiring short sellers:
- Penny stocks are tourist traps. Tourists do not care about the quality of borrow. They salivate over the story. When a recall happens, they scramble to locate. When no borrow is available, they are forced to cover, which eventually snowballs into short squeezes.
- Penny stocks are binary events. Either they go to zero, or there is a corporate action, and the share price goes ballistic. Penny stocks are high-risk, low reward trades. Get a few dan on your black belt before taking on Bruce Lee. 90% of market participants are unprofitable. The majority of the remaining 10% still refrain from short selling.
If it is any solace to Mr Campbell, Pharma Bro has since become a convicted felon.